The Law of Unintended Consequences

Veteran technical analyst, John Murphy, talks about the
profound impact that the various rounds of quantitative easing have had on the
markets.

Quantitative easing and its effects on the markets. We're here with
John Murphy, who is going to talk a little bit about what quantitative easing
means to different market sectors.

Actually it has a very, very profound impact. One of the things the Fed is
trying to do with quantitative easing-aside from trying to boost the economy-is
they're trying to move investors out of Treasury bonds and into riskier assets.
Stocks obviously are a good example, and commodities-gold, for example, has
really gone up quite sharply since QE3-but commodities in general.

Part of the reason for that is that it weakens the dollar. QE3 tends to
weaken the dollar. Every time we've had a bout of quantitative easing, the
dollar has gone down, commodities have gone up, and stocks have gone up.

But even within the bond market...we tend to talk about Treasuries, but
within the bond market itself, money has moved into high-yield bonds, for
example. High-yield bonds average what, 6%? They have a yield of 6% vs. under 2%
for Treasuries. That's been the biggest beneficiary of bond flows over the last
year.

But also investment grade bonds that yield about 4%, they're also attracting
money, and also TIPS, Treasury Inflation Protected Securities. In fact, since
QE3, the middle of September, TIPS have been the best performing bond
category.

Really?

Yeah, for the same reason that gold went up. It has an inflationary impact to
it, so money flows into TIPS.

When we talk about bonds, I think it's very important to distinguish that we
generally talk about Treasuries, so Treasuries may not be a great place to be
right now. There are other areas of bonds that actually are doing quite
well.

So actually, quantitative easing has affected the dollar. It has affected
commodities. It has affected stocks. It has also affected bonds. Then just one
final thing in stocks: one area that has really benefited is dividend-paying
stocks. They search for yield. Right now, the dividend stocks are paying about
twice what you can get from the ten-year. That's the first time we've seen that
in 50 years.

Right, and you have that risk-off encouragement from the government,
so that people are going to go out and they're going to look for their yield
somewhere else and feel a little bit more comfortable.

Well, people who are conservative, people who are bond investors who maybe
don't trust the stock-market rally, they think it's a little artificial-but they
sort of have to get in there. Dividend-paying stocks are a relatively safe way
to do it. For one thing, it cushions you against any declines.

But dividend-paying stocks tend to be defensive stocks: telecom, utilities,
consumer staples, health care. So there is also a defensive element, so it's a
safer way for a conservative investor to get in there. It seems like that's
where the Fed is trying to push people.

Right, and it seems with all the problems the banks have had, people
probably trust AT&T (T)
more than they do their local bank.

That's right. One other area I might mention is homebuilding stocks.

Are they coming back?

Last October when they started Operation Twist, when they sold short-term
paper and bought long-term paper, that really pushed bond yields lower for the
first time in a long time. Since then, homebuilding stocks have been the
strongest part of the stock market.

The homebuilding index began a rally at the point like the ITB, which is the
homebuilding ETF, it's trading at a four-year high; has been the strongest part
of the stock market. So housing is another area that is benefiting greatly from
quantitative easing.

Well, it's good to have it then, anything that will help the
economy.

I don't know what the long-term implications are, and I'm not sure it's even
a good thing, but it is affecting asset allocation. You've got to be aware of it
and you've got to know where to go.